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Rajan chooses to be different
RBI holds key interest rates

Raghuram Rajan in Mumbai on Wednesday. (PTI)

Mumbai, Dec. 18: Raghuram Rajan, governor of the Reserve Bank of India (RBI), today sprang another surprise on markets, pundits and borrowers when he decided not to raise the policy interest rate even though inflation has gone through the roof.

At the mid-quarter review of the monetary policy today, the central bank left the repo rate unchanged at 7.75 per cent. The repo rate is that at which the RBI provides short-term liquidity to banks.

The cash reserve ratio (CRR), or that portion of deposits that banks must maintain with the RBI, was also left untouched at 4 per cent.

There had been near unanimity among economists and market mavens that the RBI would raise the repo by 25 basis points. The assumption was predicated on the fact that consumer price inflation had surged to 11.24 per cent in November, while inflation measured on the wholesale price index (WPI) had leapt to a 14-month high of 7.52 per cent in the same month.

However, the RBI governor, who has raised rates twice since he assumed office on September 4, isn’t ruling out rate hikes in the future.

“If inflation does not fall, the RBI will act on off policy dates if warranted,” the RBI governor said.

Rajan told reporters that the RBI was trying to be a “responsible central bank” and the main reason for passing up the opportunity to raise rates was its reluctance to act based on a single (November) inflation number.

Admitting that the decision not to hike rates had been a close call, he said the central bank looked through the short-term volatility in inflation even as it did not want to over-react given the weak state of the economy.

A sharply polarising debate over inflation versus growth had opened up in the run up to the review when industrial output shrank for the first time in four months by 1.8 per cent in October after growing 2 per cent in September.

The RBI, therefore, decided to wait for the inflation reading for one more month before considering further action.

“We should not react to every reading of inflation. In other words, if we set the level of policy consistent with a 11.24 per cent reading on CPI and it came down to say 9 per cent or whatever number next month, would we then react to that number by changing the policy rate,” Rajan asked.

Industry was pleased with the RBI’s decision. “The RBI has demonstrated restraint and foresight to strike the right balance between inflation and growth,” said CII director-general Chandrajit Banerjee.

Waiting for the dip

Rajan said there were indications that vegetable prices might turn downwards sharply, which could see inflation dip in December. Moreover, the recent strengthening of the rupee vis--vis the US dollar (which makes imports relatively cheap) is also expected to have a disinflationary impact on prices. The lagged effect of monetary tightening since July is also expected to help contain inflation.

“We will calibrate the policy rate consistent with underlying inflation. Our sense is that the recent numbers had a lot of noise and we want to look through them,” the RBI governor added.

Some economists are concerned that the RBI may be falling behind the curve by refraining from raising the policy rate at a time inflation is riding high. They fear that the RBI may be forced to resort to stronger rate increases in the future if inflation stays at elevated levels.

Later today, the US Federal Reserve will decide whether or not to taper its quantitative easing programme under which it buys $85 billion worth of bonds every month. If the Fed tapers, the markets may face deep turmoil with massive capital outflows from emerging markets such as India.

Last month, the RBI governor said he wasn’t terribly worried about a capital outflow spurred by the Fed action. “Even if foreign investors pull out significantly more money this year than they have so far, we still can break even on capital flows,” he had said.

One reason for making such a prognosis is based on the expectation that the current account deficit — which is usually funded out of capital inflows into the country — will shrink to $56 billion, or less than 3 per cent of GDP, by March next year. Last year, CAD was at $88 billion.

This is the second time that Rajan has caught the markets on the wrong foot. On September 20, he raised the repo by 25 basis points to 7.50 per cent when everyone had expected him to stand pat after the US Federal Reserve chose not to wind down its massive bond-buying programme.

The Fed’s decision had sparked expectations that Rajan would refrain from tinkering with the rates and would only roll back some of the money-draining measures that the RBI had announced in July.

When he assumed charge on September 4, Rajan had said: “The Reserve Bank of India should be a beacon of stability as to its objectives. That is not to say we will never surprise markets with actions. A central bank should never say “Never”!”

The pundits will clearly have to be a little more cautious when trying to second-guess Rajan’s actions.

 
 
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